You have flawless credit and have never been a day late on your reasonably priced, fixed-rate mortgage.

So what does the subprime mortgage meltdown mean to you?

A great deal, if you plan to buy anything or to borrow money in the coming months.

And if you want to sell your house, good luck. Chances are, it's worth less than you thought.

Soaring default rates on high-interest subprime loans and tumbling home prices have been dragging down the U.S. economy during the past 12 months. Problems are likely to intensify over the next year as more subprime loans go bad and housing values fall further.

Economic news has certainly been grim. The reports are mostly served in two flavors these days: gloomy and gloomier.

Prices are up. The stock market is down. Loans, whether for houses, cars or college tuition, are more expensive and generally harder to get. A weakening dollar has sent fuel prices to record highs.

Falling home prices and the growing number of foreclosures have created the worst U.S. housing slump since the Great Depression.

Some economists think it's not a matter of if a recession is coming, but when. Some think it's already here.

So what do problems with subprime loans, aimed at borrowers with poor credit, have to do with all of this? More than you might think.

Two events triggered crisis

Economic crises begin with triggering events. In this case, there were two: Too many people with subprime loans stopped paying their mortgages and demand for homes waned, causing housing prices to drop.

The effect on the financial markets was almost immediate. Banks and investment firms had bought billions of dollars' worth of bonds backed by these subprime mortgages, expecting to make a healthy rate of return off the interest and principal borrowers paid.

But rising defaults and foreclosures among subprime borrowers meant there wasn't enough money coming in to pay investors their promised rates of return. Falling home values meant that holders of these mortgages could not recover the losses caused by subprime mortgage defaults.

The result? Banks lost billions of dollars, which meant they did not have the cash needed to make loans of all kinds.

"The financial sector is the oil that lets the economy run," said Robin Dubin, an economics professor at Case Western Reserve University. "So if that seizes up, it definitely slows the economy down."

Businesses are finding it more difficult and expensive to get the loans they need to remain competitive. When businesses can't compete, people lose their jobs. When people lose their jobs, they are unable or unwilling to buy products and services or to pay their debts. That drags down the economy further.

Perception is often reality in economics, and measures of consumer and business confidence show that both are at low ebb. People and business owners are less likely to spend money when they believe economic trouble lies ahead.

Bank failures are forecast

The trouble has spread quickly. Investors have become nervous about nearly all types of mortgages -- and for good reason.

In the final months of 2007, late payments jumped 7 percent for subprime borrowers. One in every six subprime borrowers was behind on payments. The delinquency rate for borrowers with conventional mortgages jumped 4 percent.

The Federal Reserve has been pumping hundreds of billions of dollars into the banking system to keep the machine running. Yet there are estimates that a large number of banks will go out of business or will be forced to merge with healthier banks in the next year.

"The economy is going to weaken from here and there will be further credit problems for the industry, so you are going to see bank failures," said Gerard Cassidy, managing director of equity research and banking analyst with RBC Capital Markets in Portland, Maine. "We think there will be more bank failures in the next three years than there were in the last 10 years."

There is nothing inherently wrong with subprime mortgages. Risk has a price, and because these were mortgages made to people with either no down payment or a poor record of paying their bills, the loans understandably carried higher interest rates and fees.

The subprime business model had obvious problems, though.

Home buyers with good credit and money for a down payment receive considerable scrutiny of their assets, debts and ability to pay before a lender gives them a market-rate mortgage loan.

But in the subprime world, borrowers had to prove very little about their creditworthiness, thanks to products such as "no document" and "stated-income" loans. In the mortgage industry, these became known as "liar's loans."

Securities sold before loans made

For a while, everyone was making money off subprime loans.

Mortgage lenders such as Argent Mortgage Co., New Century Financial Corp. and Countrywide Financial Corp. couldn't sell subprime mortgages fast enough for Wall Street, which would take bundles of these loans, classify them by their risk of default, and sell them to banks, hedge funds and institutional investors. Everyone loved the cash flow that subprime mortgage-backed investments created.

On their face, these securities looked like good bets. Credit agencies such as Moody's Investors Service and Standard & Poor's put their highest ratings on large classes of subprime investment pools.

Demand rose to the point where brokers were selling these securities before the loans were even made, which put pressure on lenders to write loans as quickly as possible. Standards for underwriting -- evaluation systems that lenders are supposed to use to weed out really bad borrowers -- got tossed overboard.

There had always been expectations that a certain percentage of subprime borrowers would default on their mortgages. The typical default rate was expected to be 3 times higher than for conventional mortgages.

But as long as defaults didn't fall below a certain level and house prices continued to rise, there was plenty of money to be made.

Early signs of trouble

There were some early signs that this subprime business model might be flawed. Foreclosure rates in places like Cleveland and Detroit had risen to alarming rates by 2004.

Mortgage lenders, Wall Street and investors were content to keep buying and selling subprime loans because housing prices in places like Fort Lauderdale, Fla., and Laguna Beach, Calif., continued to rise.

Bad mortgages in the Rust Belt were easy to hide when they were included in billion-dollar pools of mortgages written for homes in high-priced housing-bubble communities. But when prices started falling and foreclosure rates in hot markets started to rise, the subprime house of cards collapsed.

Whether it's housing or dot-com companies, there is a reason these periods of prosperity are called bubbles. Bubbles burst, and when they do, they leave a slimy mess.

The first rumblings of impending problems came about a year ago when news surfaced that one of the country's biggest subprime lenders, New Century, was broke and headed toward bankruptcy. A number of banks were reporting higher-than-expected losses from their subprime mortgage portfolios.

The economic crisis enveloping the country began in earnest in July when investment bank Bear Stearns Cos. announced that two of its hedge funds had lost $20 billion in risky bets on subprime loans. On Friday, the Federal Reserve invoked a decades-old procedure to provide Bear Stearns with much-needed cash to remain open for business.

Subprime lenders by that point were tumbling into the abyss. Not surprisingly, the FBI has opened an investigation into the business practices of more than a dozen of these lenders.

Losses due to subprime loans are at $150 billion and rising. Standard & Poor's last week said total losses could reach $285 billion. Other financial experts have estimated that losses may exceed $400 billion by the time the dust clears.

Doug Duncan, the Mortgage Bankers Association's chief economist, said in a teleconference last week that more bad news is on the horizon.

"Our general outlook is that you should expect to see -- as long as house prices are declining -- some continued rises in delinquency and foreclosures," Duncan said.

It's unclear when the credit, mortgage and housing markets will reach bottom.

Daniel Mudd, chief executive officer of Fannie Mae, the government-chartered agency that provides money for mortgage lending, said in a written statement last month that the decline in the housing market should end in late 2009.

"We are working through the toughest housing and mortgage markets in a generation," Mudd said.

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